Chapter-Four Show
Audit of Property, Plant, and Equipment and the Related Depreciation 4.1. Overview of property, plant and equipment The term property, plant and equipment (fixed assets) include all tangible assets with a service life of more than one year that are used in the operation of the business and are not acquired for the purpose of resale. Three major subgroups of such assets are generally recognized.
Fixed asset constitute a significant proportion of the total assets of many organizations particularly those engaged in manufacturing activities. Audit of fixed asset is, therefore generally considered to be an important part of an independent financial audit. Though the number of transactions involving fixed assets is smaller in number, the amount involved in these transactions will be very high. Hence the auditor has to give more attention while auditing the transactions relating to fixed asset. 4.2. Auditors’ objectives in auditing property, plant and equipment The auditor’s objectives in the audit of fixed assets are
In conjunction with the audit of property, plant, and equipment, the auditors also obtain evidence about the related accounts of depreciation expenses, accumulated depreciation, and repair and maintenance expenses. 4.3. Internal controls relating to fixed assets The auditor studies and evaluates the accounting system and the effectiveness of internal control relating to fixed assets. The auditor’s study and evaluation of internal control relating to fixed assets covers the following aspects:
1. Segregation and rotation of duties: The auditor has to see whether there is proper segregation of various duties relating to fixed assets such as
The auditor also has to see whether the duties of various persons relating to fixed assets are rotated periodically or not. 2. Authorization of acquisition, transfer and disposal of fixed assets:
3. Maintenance of records and documents
4. Accountability for and safeguarding of fixed assets
5. Independent checks: The auditor has to see whether there is any internal audit for fixed assets and determining the coverage and effectiveness of the internal audit. The auditor has to examine the scope of the work of the internal auditors and their reports. Substantive procedures for fixed assets The auditor determines the nature timing and extent of substantive procedures relating to fixed assets after evaluating the effectiveness of internal controls. The procedures normally followed are the following (A). Examination of records and documents.
(B). Review or observation of a second verification Though the physical verification is the duty of the management, the auditor can review or observe the verification by examining the documents relating to the physical verification. The procedures followed are:
(C). Examination of Valuation and disclosure
(D). Analytical Procedures: -The analytical procedures employed by the auditors in the audit of fixed assets are the following:
(E). Obtaining Management Representation The auditor has to obtain an appropriate representation form the management concerning the fixed assets stating that the fixed assets shown in the balance sheet are arrived at after considering all capital expenditures on additions, eliminating the cost and accumulated depreciation relating to the items discarded, destroyed and disposed off and adequate depreciation has been provided for during the current year. 4.4. Audit program for auditing fixed assets The following procedures are typical of the work required in many engagements for the verification of property, plant and equipments. A) Consider internal control over property, plant and equipment 1. Obtain an understanding of internal control over property, plant and equipment Auditors may use written description, flow chart or internal control questionnaire to describe the nature of client’s internal control structure. After preparing description of internal control, the auditors will determine whether the controls as described to them have been placed in operation, whether there is appropriate segregation of duties and considered the misstatements that may occur. 2. Assess control risk and design additional tests of control for the assertions about property, plant, and equipment. Based on an understanding of the client’s internal control over property, plant and equipment, the auditors develop their planned assessed level of control risk for the various financial statement assertion assertions and obtain additional evidences of the operating effectiveness of the client’s controls by designating additional tests of control. 3. Perform additional tests of controls for those controls that the auditors plant to consider to support their planned assessed levels of control risk. As auditors obtain an understanding of the client’s internal control; certain tests of control are performed. E.g. select a sample of purchase of plant and equipment to test the control related to authorization, receipts and proper recording of the transactions. 4. Reassess control risk for each of the major financial statements assertions about property, plant, and equipments based on the results of tests of controls and, if necessary, modify substantive tests. The final step in the auditor’s consideration of internal control involves a reassessment of control risk based on the results of the tests of control. On the basis of the reassessed level of control risk auditor modify their planned program of substantive testing procedures for property, plant, and equipment assertions. B) Perform substantive tests of property, plant and equipments and related depreciation transactions and balances The objective of major substantive testing procedures of property, plant and equipment balances are given in the following table.
4.5 Auditors perspective towards depreciation Depreciation is the decrease in the value of the asset due to wear and tear, obsolescence, lapse of time etc. Fixed assets are to be disclosed in the balance sheet at their cost or at the revalued amount less depreciation Determining the annual depreciation expense involves two rather arbitrary decisions by the client company: first, an estimate of the useful economic lives of various groups of assets, and second, a choice among several depreciation methods, each of which would lead to a different answers. The wide range of possible amounts for annual depreciation expense because of these decisions by the client suggests that the auditors should maintain a perspective of looking for assurance of overall reasonableness. Specifically, overall tests of the year/s depreciation expense are of special importance. Accordingly, the auditor has to examine whether adequate depreciation has been provided in the books in respect of all depreciable assets according to the provisions of the relevant statutes. While auditing depreciation, the auditor has to examine the following points in respect of depreciation
4.5.1 The auditors’ objectives in auditing depreciation When evaluating the reasonableness of depreciation (with accounting estimate), auditors use one or more of the following three basic approaches. 1). Review and test management’s process of developing the estimates 2). Review subsequent events or transactions that might have bearing on the estimate to management’s estimate 3). Independently develop an estimate of the amounts to compare to managements estimate. 4.5.2 Audit program-Depreciation expense and accumulated depreciation The following outlines of substantive tests to be performed by the auditors in reviewing depreciation are stated in sufficient detail to be largely self-explanatory. 1. Review the depreciation policies set forth in company manuals or other management directives. Determine whether the methods in use are designed to allocate costs of plant and equipment assets systematically over their service lives.
2. Obtain or prepare a summary analysis of accumulated depreciation for the major property classification as shown by general ledger accounts, listing beginning balances, provisions for depreciation during the year, retirements, and ending balances.
3. Test the provisions for depreciations a) Compare rates used in prior years and investigate any variance. b) Test computations of depreciations for provisions for a representatives number of units and trace to individuals records in the property ledger. Be alert for excessive depreciation on fully depreciated assets. c) Compare credits to accumulated depreciation accounts the year’s depreciation provisions with debits entries in related depreciation expenses accounts. 4. Test deductions from accumulated depreciation for assets retired. a) Trace deductions to the working paper analyzing retirements of assets during the year. b) Test the accuracy of accumulated depreciation to date of retirements. 5. Perform analytical procedures for depreciation a) Compute the ratio of depreciation expenses to total cost of plant and compare with prior years. b) Compare the percentage relationships between accumulated depreciation and related property accounts with that prevailing in prior years. Discuss significant variations from normal depreciation program with appropriate members of managements. Which of the following procedures would an auditor most likely perform in obtaining evidence about propriety of PPE additions?Which of the following procedures would an auditor most likely complete to test the existence assertion for property, plant, and equipment? Obtaining a listing of all current-year additions, vouching significant additions to original invoices, and determining that they have been placed in service.
Which of the following procedures could the auditor perform to test the effectiveness of controls over asset impairment?Which of the following procedures could the auditor perform to test the effectiveness of controls over asset impairment? Inquire of management as to its process for determining assessment impairment, and follow up as appropriate.
Which of the following procedures is most likely to prevent the improper disposition of equipment?Which of the following procedures is most likely to prevent the improper disposition of equipment? Separation of duties between those authorized to dispose of equipment and those authorized to approve removal work orders.
Which of the following audit procedures would be least likely to lead the auditor to find an unrecorded fixed asset disposal?excessive recurring losses on assets retired. Which of the following audit procedures would be least likely to lead the auditor to find unrecorded fixed asset disposals? Review of repairs and maintenance expense.
|